Book Review & Giveaway: “Your Money Ratios”

your-money-ratiosPublisher: The Penguin Group.  Hard cover. 257-pages. Price: $26.

Author: Charles Farrell, JD., LL.M., investment adviser with Northstar Investment Advisors, in Denver.  He writes the “Retirement Roadmap” column for CBS Moneywatch.

Review: “Your Money Ratios” sings to me!  For someone who loves using ratios such as the 1/10th rule for car buying, and 30/30/3 rule for home buying, I absolutely adore this book.  Charles’ writing style is very balanced and easy to understand.  When it comes to math, many people, including myself fall asleep.  But, if you can just do simple division and multiplcation, this book will keep you on the right path towards financial security.

Charles’ “Unifying Theory of Personal Finance” is his core philosophy that all decisions you make should help move you from being a laborer to being a capitalist.  In other words, make money work for you, and not the other way around.  It’s important that with every single monetary decision you make, you ask yourself will this help you become a capitalist or not.

Capital To Income Ratio

The first ratio Charles introduces is the Capital to Income Ratio (CIR).  Capital is defined  as the savings in your 401K, IRA, annuities, CDs, cash value of your life insurance, savings, equity in commercial and rental real estate, and the fair market value of any business interests.  Capital does not include the equity in your primary residence because it does not generate income.  The real return of your home is the rent-free use of the property once you pay off your mortgage.

The underlying goal is for everyone to have a CIR of 12 by age 65 i.e. $1.2 million in capital if you average $100,000.  With a CIR of 12, one should be able to retire financially secure while living off 80% of your pre-retirement income due to the returns from capital and social security.  While working we probably live on about 60% of your actual income due to expenses such as one’s mortgage, which will no longer be there when we retire.

Your finances hit a tipping point when your Capital to Income Ratio hits 2.  At a CIR of 2 your earnings from you capital will generally add more to your wealth than the amount you save each year.  Over a 40yr savings cycle, you contribute 30% 70% are from earnings.

The Savings Ratio

To get to a Capital Income Ratio of 12, Charles highlights on two savings rates: Save 12% of your annual income ever year from ages 25-40, and save 15% every year after wards.  The math works, and obviously the math works even better if you can save more of your annual income.

To clarify, the Charles’ 12% and 15% savings ratios include your 401K contribution..  Charles believes that your 401K is key to financial independence due to employer matches and tax free contributions.

I challenge readers to max out their 401K and save an additional 12-15% of their gross income. Mentally write off your 401K amount, and pray it’s there at age 59.5.  My strong belief is that your net worth is an illusion, except for the cash and most liquid of assets.

Your Debt Ratios

One needs to differentiate between income-producing debt and income-reducing debt  When you take on debt, you need to leave enough for you to meet the savings ratio  Owning a home and paying of your debt increases your retirement income and helps move you from laborer to capitalist.  “Deemed Income” is the investment income you get to keep in retirement because  you don’t have to use that income to pay a mortgage or rent.

Education debt, is good debt, but aim to keep it to 75% or less of your average 10 year gross income.  Financially, it is better for your kids to take on the debt than you provided they stick to the Education Debt Ratios.

Charles, like others believes there is an education bubble.  Tuition costs are ridiculous and will eventually fall because income growth doesn’t support the cost.  Charles advises not saving for your kids education before you save for your own!  If you don’t save enough for yourself, your kids inherit your financial burden and have to take care of you.  Your financial independence is a great gift to your kids.

Your Investment Ratio

It’s all about playing offense (stocks) and defense (bonds) to come out ahead.  Charles recommends a permanent 50%/50% allocation your entire working life.  I find this too conservative.  I like following your age as a percentage to allocate to bonds i.e. if you’re 35, somewhere around 35% of your investments are in fixed income securities.

Charles is super risk adverse because he wants to avoid big losses.  As an investment adviser, and given his age, I have a feeling he has seen tons of carnage over these past two investment cycles.  A 50% portfolio decline requires a 100% increase to get back to even.  A 80% portfolio decline requires a 400% increase!

Social Security – The Point of Contention

Charles fears Congress will go overboard in fixing SS, and create one large wealth-transfer.  Despite the “fix”, SS will survive. Lower paid workers get much more out of the system than higher paid-workers, based on their actual contributions.  It’s important for everyone to understand the basics of SS, to not change the program from a long term retirement program into a welfare program.

Your FICA tax is 7.65% from you, 7.65% from employer of which 12.4% goes to SS, and 2.9% goes to Medicare.  You need to work for at least 10 years for a covered employer before you can receive benefits.  Cap is on $106,800 of the income you pay, thank goodness for many.  SS adjusts for inflation is great.  And if you’re married, your spouse has the right to benefits equal to the higher of his or her OWN benefit, or one half of yours.  Not bad!

By the way, if you were born after 1960, the full-retirement date to receive social security benefits is 67!  You can decide to take reduced benefits starting at age 62.

Conclusion

“Your Money Ratios” has the potential to be one of 2010’s best sellers in the personal finance space. I love everything about the book, from the tone of the author, to his simple instructions, to the way the book is packaged.  There’s no doubt in my mind that if you follow Charles’ instructions, whether you are 25 or 45, you will be able to reach financial independence by 65.  Go to your local bookstore or Amazon and check it out!

Go to www.yourmoneyratios.com, type in the code 778811 to check out your ratios and see where you stand!

BOOK GIVEAWAY RULES: Two Books To Win!

* Comment on: What your current Capital to Income ratio is, and whether you think it’s realistic to reach a CIR of 12 by age 65.  Feel free to provide your thoughts on why you are satisfied or unsatisfied with your current status and what the right CIR is.  Are you maxing out your 401K, and if so, how much more of your gross annual income are you saving?  Do you believe full Social Security benefits will exist in 25-30 years?

* Twitter: Retweet and share with your friends.  Ideally, you will read the review and share your comments.

* Enlist: Sign up for our e-mail or RSS feed.  Let us know in comments.

* Do all three and you have a higher chance of winning.  I really want this book to go to someone who really wants it, and will read every page and take it to heart.

Keigu,

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Twitter @FinancialSamurai and subscribe to our RSS feed.

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. says

    Charles recommends a permanent 50%/50% allocation your entire working life. I find this too conservative.

    I agree that working with these sorts of ratios can be illuminating. It helps tell you what matters and what doesn’t.

    When I tell people about the wonders of Valuation-Informed Indexing, I get the sense that often they don’t see why it is such a big deal. Some think “well, that’s nice” but that’s all. You have to work the numbers to see what a big deal it is.

    What if 50 percent is in some circumstances far too conservative and in other circumstances far too risky?In other words, what if Charles and you (Sam) are both right?

    Now — What if you could know in advance in what circumstances Charles is right and in what circumstances you (Sam) are right? Do you see how the gains would add up over time if over the course of your entire investing life you were taking advantage of this knowledge? You would be gaining higher returns at lower risk for your entire investing lifetime. It only gives a small edge in the short term but in the long term it translates into being able to retire five years sooner.

    If you do a regression analysis of the historical stock-return data, you find that the most likely annualized 10-year return on stocks purchased at the prices that applied in 1982 was 15 percent real. At the prices that applied in 2000, the most likely annualized 10-year return is a negative 1 percent real.

    A 50 percent stock allocation is far too risky at the prices that applied in 2000. A 50 percent allocation is far too conservative at the prices that applied in 1982. Our belief in Buy-and-Hold is causing us to wildly overinvest in stocks at some times and to wildly underinvest in stocks at other times. The net effect is that we are pushing off our retirements by many years.

    That’s why we are in an economic crisis today. We are making ourselves poor by our unwillingness to question the Buy-and-Hold dogmas.

    Rob
    .-= Rob Bennett´s last blog ..Stocks Are a Lot Less Risky Than You Think =-.

  2. Kevin M says

    My CIR is about 1 if you take out equity in our residence. Pretty low considering I’m almost 35, but I’m comfortable with it since most occurred within the last 4-5 years and we have no debt other than our mortgage.

  3. says

    If the CIR is calculated by dividing capital by income, then our’s is a paltry 0.5, assuming income is your pretax income. Not at all satisfied with that figure and don’t think we could make it climb up to 12 by age 65. :( Definitely need to do something to improve our finances!

    I’m not maxing out my 401k, but I’m at the maximum % where they match you dollar for dollar. We saved around 25% of our gross income this year, but this is the first year where both of us had decent paying jobs, so we started at 0, and not sure if we can maintain that rate. (my post about Year End Stats talks about this if you’re curious)
    .-= thriftygal´s last blog ..2010 Resolutions =-.

  4. Jon says

    In order to max out a 401k you have to have one, so might be a while for me. Am looking to open a Roth this year though. Good looking screenshot for the fund- glad to see it worked out. That’s a LOT of money :D
    .-= Jon´s last blog ..PORTFOLIO UPDATE: 11:33 AM Eastern =-.

  5. says

    My CIR is a paltry 0.5 assuming income is gross income. Sad isn’t it? And doubt it can rise to 12 by 65 maintaining the status quo! So need to get off my butt and do something to improve our finances.

    We did manage to save around 25% of our gross income this year (detailed in my recent post), but that’s an anomaly, considering that this is the first year in which both of us had decent paying jobs. We’re hoping we can maintain this rate by not keeping our fingers crossed… And I’m not maxing the 401k, but contributing the maximum % where they match you dollar to dollar.
    .-= thriftygal´s last blog ..2010 Resolutions =-.

  6. says

    @ JON – Thanks to your tip! Yes, I wanted to make the fund as realistic as possible and launched with close to $1.7 billion, with seventeen $100 million positions, hence why the market cap requirement is over $750 million. We are KILLING IT today with Lenar up huge post great results.

    Definitely open up an IRA, or Roth for your case and fund it to the max!

    @ THRIFTYGAL – I definitely think you’ll do well and make a higher CIR multiple by age 65. You can do it, esp since you just started with your decnt paying jobs!

    @ KEVIN M – Sounds like you have a big denominator i.e. salary perhaps!

  7. says

    Great review Sam! It’s funny, you must have been a pretty good student because your reviews are a lot more indepth and helpful than a couple of the others I’ve seen. What was your GPA?

    My CIR is about 4, and I’m in my early 30’s. It was a race to see which side of the equation would head to zero first! My income got cut big last year, which conceivable helps my CIR since the denominator gets smaller.

    Looks like Charles’ point is to just use these ratios as guidelines, and not hard fast rules. a 12X CIR should work to provide a comfy retirement at 65, however, who wants to work that long? I know you don’t!

    So really, Charles needs to expand his CIR ratio, and give us insight as to what the right ratio is for someone who wants to retire at 40, 45, 50, 55, 60!

    Social Security will be around in 25-30 years for sure. It might not pay 100% of its benefits, but at least 50% no doubt!

    Would love to read the book!

    The Genius
    .-= The Genius´s last blog ..An undergraduate think tank? =-.

  8. Jesse says

    From an engineer, ratios are beautiful. They can give so much information and make so many relationships. CIR = 1.85

    @ThriftyGal: Don’t beat yourself up! Saving 25% of your gross is superb.

    Not sure why the author chose CIR instead of CER
    *Capital-Expense Ratio…just made that up right now :)

    Even assumes living off 80%. 1.2m / $80k = CER 15 which is equivalent to CIR 12

    So, ThirftyGal if it helps – you’re actually at 0.67 CER!
    Based on 1/2 = 0.5 so saving 25% = 1/1.5 = 0.67

    FS – How long will I continue this phantom blogger charade? There’s a chance I could have a handicapped website up this weekend…but don’t hold your breath. Also, please remove me from the drawing since I recently got that other book. I can pick this up at the library.

  9. says

    I don’t have a 401K, and instead of contributing to social security, I contribute to CalSTRS. It’s a pension plan. My employer, a school district, is now matching my contributions now that I’ve worked for them over 5 years. I’m not really sure how this will all play out when I retire. As for any additional retirement, I’m way behind! I need to get on the ball and been thinking about a ROTH IRA. I’m not even going to figure out my CIR yet, I’d be afraid it would be in the negative or a measly .01! This year, I need to make more money! (or live in a tent to save money on rent. :( )
    .-= Little House´s last blog ..Energy Efficient House Plans =-.

  10. says

    @ Jesse – That is an honorable thing you are doing, withdrawing from the drawing. I hope someone who REALLY wants this book, gets this book. I truly believe this is one of the BEST books on PF in a long while. It’s not gimmicky, it’s a great guide. Look forward to seeing your site. Just put it up!

    @ Little House – CalSTRS sounds good. Before you do a ROTH, please wait until next seek as I’ve got a post to make you think before doing a ROTH. A traditional could be just fine.

    @ The Genius – Thanks man. A CIR of 4 sounds great for your age. Keep on the righteous path. Charles does mention a CIR target for a younger age, but not that young. So yes, that would be great if he can come up with CIR ratios for earlier retirement ages like 40.

  11. says

    Sounds like a pefect book for me! I scored 5.71 ratio. Though it says I should pay down more on my mortgage. I think it should consider where you live and your taxes for that state. For us to reach 12 is definitely doable since we are almost 1/2 way there and have 25 years still to retire. I’m very happy with our CIR and we do max out our 401K and if we can IRA (I don’t have any specific retirement plans in my biz). Personally I’ve been thinking of using that money to invest in things outside of retirement plans. This is for a bunch of reasons.

    We save 35% of our income.

    I tweeted it: http://twitter.com/InvestorJunkie/status/7489658029

    I am betting that SS will NOT be around when we retire. If it is around I’ll use it to buy lotto tickets. ;-)
    .-= Investor Junkie´s last blog ..2010 Is Here! Where’s the Monolith? =-.

  12. says

    @ IJ – Good stuff! Actually, since you are killing it (not in the Samurai Fund though :)), I don’t think you need the book at all! The abridged review here is good enuf 4 u!

    @ Lisa – Thanks for giving me the opportunity to read and review the book! It really is one of the best PF books I’ve read in a long time. Please ping Charles for me if you can, and see what his thoughts are on providing ratios, specifically the CIR ratio for those who wanna retire early i.e 40, 45.

    Thanks!
    .-= admin´s last blog ..Everything Is Rational – The Answer To All Things Irrational =-.

  13. says

    Sounds like a great book! I really like comparisons with the averages. To often it’s hard to find such specific stats… Most of the time it’s ballpark numbers. But the online calculator mades it directly relevant to us! Our age and income compared to the average for our age and income, very nice! I don’t like the range ones…

    I like to do “What If” scenarios (I’m a number crunching kind of guy…), and the calculator you pointed us to is great for doing that!

    Thanks!
    .-= Don@MoneyReasons´s last blog ..Reasons To Save Money =-.

  14. says

    @ DON – Yeah, the calculator is pretty sweet. I’m a number cruncher too. Iz fun!

    @ John – Your net worth is an illusion, and I feel for so many who proclaim they have X amount of wealth, when they really don’t. It’s a crutch!

  15. Charlie says

    “Charles advises not saving for your kids education before you save for your own! If you don’t save enough for yourself, your kids inherit your financial burden and have to take care of you. Your financial independence is a great gift to your kids.”

    I LOVE the above point. I so wish my parents had read that before I was born!!!! I’m truly grateful for everything my parents did for me growing up but now that we’re all older I sure wish they’d done a better job of saving.

    I also think 50% in debt investments is conservative and I love your suggestion to use a percentage matched to your age. Not only is that easy to remember it’s a great way to increase exposure over time, to get more conservative.

  16. says

    @ Charlie – Yeah, I can’t imagine if one had parents who got in financial trouble, and needed to rely on their kids for money, when the kids themselves are struggling to make ends meet! I’m glad my parents kicked my butt financially, and led by example.

    Thanks for commenting!

  17. says

    Thanks for the encouragement Sam and Jesse, I hope you are right but it’s actually worse than I thought. I somehow missed the last sentence of Sam’s post when I first read it and did not use the online calculator. Instead I manually divided capital by income. But after reading the latest comments I went back and reread the post and plugged in my numbers on the online calculator. My revised score is… *drumroll* 0.35! Yikes!!!

    This is probably a kick in the rear I needed. Srimping and saving our paychecks ain’t going to cut it anymore!
    .-= thriftygal´s last blog ..A Confession =-.

  18. says

    1. My CIR is 0 or should actually be less than zero if that’s possible. I’ve had my own Central Park West gal to deal with but with any luck I should be able to get back on track and reach my retirement goal by age 70 (I’m 40 now). My income has been steadily rising despite the recession and I’m always looking for reliable additional sources of income.

    2. Retweeted (man how I hate to have to use the word “tweet” in a sentence). Will try to remember to tweet again later when there’s more traffic.

    3. Signed up for the email feed, I prefer to use Outlook.

    As you can tell I loves me some ratios and like to make sense of things with numbers (like my completely un-PF-related space travel post). I think this would be a great book to help me get back on track financially.
    .-= David @ MBA briefs´s last blog ..The biggest marketing mistake you can make =-.

  19. George says

    1. My CIR is about 1.7 right now if I include the value of my employer pension (I’m 32). I think I should easily be able to hit a CIR of 12 by age 65, but my goal is to hit that point sooner and have the possibility of retiring early.

    2) I’ve retweeted the link.

    3) Signed up for the RSS feed. Didn’t know this blog existed until I found it via a search for the book. I really would like to have a read through it – I’ve always thought the idea of ratios made sense to determine financial goals, and getting a free copy in a contest is a frugal way to read! :-)

  20. Mike Hunt says

    Should the CIR be replaced by CER or Capital to Expense ratio? The reason being if I use CIR I’m at about 5-6 at age mid-thirties but since we have such a high savings rate if we use CER the ratio climbs up to be about 30 or so!

    It would be great to get a copy of that book…

    -Mike

  21. says

    Interesting sounding book, FS. My CIR depends on whether we’re using my current unemployment income (in which case it’s somewhere in the 0.8 range) or the income I was making at my last job (in which case it comes in at 0.4). I think I’ll be able to reach a ratio of 12 by retirement age; contributing according to this book’s guidelines, I’ll be at a ratio of 13 by age 65 (making conservative estimates of growth and liberal estimates of inflation). I do think it’s better to assume that Social Security won’t be able to provide anything by the time I retire, and a more appropriate CIR ratio to shoot for is 20 (which, at a four percent safe withdraw rate will give us the desired 80% of our income). (That require a more robust saving rate, in the twenty percent range, but better to save too much than too little, right?)

    I do like the idea of using expenses rather than income for this and other similar calculations; it tells you much more about whether your investments (and the income you can derive from them) are sufficient to cover you needs. With that ratio, assuming withdrawing four percent of your total investment to cover your expenses, you’ll need a CER of 25 to meet your investment needs. (So, Mike Hunt, you are way ahead of the game!)

    I appreciate your challenge, FS, but for those of us who aren’t making six figures, it’s a bit unrealistic to max out our 401(k)s AND then save an additional 12-15%. If you’re making $50,000, for instance, contributing $16,500 means 33% of your income. Add in 12% to 15% contributions, and your paycheck is almost cut in half before you even get a dollar to spend. With taxes on top, you’d be lucky to have one third of your gross income left for living expenses. (Although, if you can survive on that, your CER ratio will be increasing by 1.5 or more each year; that’s the way to do it if you want to retire REALLY early.)

    I also think the 50%/50% stock-bond mix is a bit too conservative; if you’re going for a permanent ratio, 60%/40% or 70%/30% seems more reasonable. That said, I do like making your investments become more conservative over the course of your life; that’s the best way to do it, I think.

    So, commented, tweeted (as amateurfinancier), and I’m already following your RSS feed; where’s my book already? ;)
    .-= Roger´s last blog ..Fifteen Things to Tell A Younger Me =-.

    • says

      Roger – Thanks for your comment. Unfortunately, you’re a week too late as the contest winners were announced in the last Katana! You would have been a perfect candidate for the book. Seriously, I loved the book and that’s why I told you when the contest was open to stop by! lol.

      If you’d like, I can speak to Charles (author), who we are e-mailing back and forth, and see if he can send you a book for free, if you provide a review? You do good ones, so maybe he’ll say yes.

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